After months of anticipation and many market pundits believing the Fed was ready to raise rates, no action was taken at the Federal Open Market Committee (FOMC) meeting. Rates will remain unchanged at 0 – 0.25%. Fed Chair Janet Yellen, when speaking about the Fed’s decision to delay their hike, noted slowing growth in China, an overall “troubled” global economy, and the fact that inflation is below their target. Regarding China, while the Fed noted that they have “long expected” growth in China to slow, they indicated that recent developments had them ask “whether or not there might be a risk of a more abrupt slowdown than most analysts expect.”
When speaking on the current economy, Yellen noted that the recent drop in equity prices and appreciation of the U.S. Dollar could restrain U.S. economic activity. Many economists and market participants have long questioned the Fed’s intervention with regard to equities markets, saying they should not base rate hikes on how the markets are performing. When asked about this, Yellen noted that, while the Fed does not target the markets, they do factor how market performance affects domestic activity. She said, “The Fed should not be responding to the ups and downs of the markets and it is certainly not our policy to do so. But when there are significant financial developments, it’s incumbent on us to ask ourselves what is causing them.”
In regard to inflation, some FOMC members have long stated that they would “wait” to raise rates until inflation rises to their 2% target. The reasoning behind this is that, when rates are low, people tend to borrow more and thus have more money to spend. This causes the economy to grow and inflation to increase. Generally, as rates rise, the opposite is true. People borrow less, have less to spend, which causes economic growth to slow and inflation to decrease. Therefore, the Fed is reluctant to raise rates at a time when inflation is below its target. This is very likely a big reason they did not raise rates this time around.
Fed’s Next Move:
The market will now continue to fixate on the Fed’s next move. Yellen did not rule out an October rate hike, though she seemed to be hinting towards a December hike. She noted that recent developments “have not fundamentally altered our outlook”, perhaps indicating she was looking for a December hike all along. While she said most policy makers still expect a rate increase this year, central bank officials said in a statement that “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
In reviewing the chart below, we are able to see how each FOMC member “sees” rates in 2015 – 2018 (and “long-term”). For the most part, FOMC members are uniform in both their timing and the “amount” of the hike. However, it is interesting to see one member – thought by many to be Minneapolis Fed President Narayana Kocherlakota – forecasting for negative interest rates in both 2015 and 2016. This begs the question to what data is forecasted to be so bad that the FOMC would actually consider lowering rates this year or next?
The Fed’s “non-decision” saw markets in Europe fall, with the U.S. markets finishing this week lower as well. Banks and financial sector companies, who likely will benefit from rising rates, sold off more than the broader market. Traders took the Fed’s remarks to mean the U.S. economy is still showing some signs of weakness. As the markets will continue to watch for clarity from the Fed, it is likely we will continue to see a bit of volatility in the near-term.